I think George Osborne could get the economy growing more quickly if he cut VAT.
I’ve already written about what I expect the Chancellor to announce in this year's Budget speech.
Now I’d like to look quickly at what I think the Chancellor should do in his Budget.
Too much austerity
My view is that Osborne has given us too much austerity since 2010. Spending is too low and taxes are too high. If we’re going to get the ecomomy moving again, Osborne should cut VAT from 20% to 16%.
He should cut VAT to 16% and get the economy moving again.
Justification
Osborne justifies his austerity policy with two arguments:
1. If an individual hits financial problems, he/she should cut their spending to get back on track. Surely a government should follow the same approach?
2. Long-term interest rates will allegedly rise if the Government switches from its austerity policy.
However, individuals aren’t the same as economies. The difference is that if a government cuts spending, the economy can then suffer, and then tax receipts can fall. So tax revenue falls as government spending falls, and the deficit doesn’t contract as fast as Osborne had expected.
[SPOTLIGHT]In my view, tax cuts and spending increases will boost the economy. More economic growth will boost tax revenue for the government and also mean lower welfare spending as more people will have jobs. In the medium term, my approach will actually reduce the deficit more quickly than Osborne’s austerity policy.
Don’t get me wrong, my approach isn’t appropriate in all circumstances. Government spending increases can sometimes trigger inflation.
Spending increases can also ‘crowd out’ the private sector. In other words, companies can’t grow as fast they would like because the higher government borrowing is driving up interest rates.
But right now, long-term interest rates are extremely low and I don’t see any sign of change there. What’s more, there’s plenty of spare capacity in the economy – so increased Government spending won’t push up inflation.
Granted, a 4% cut would initially cost around £20 billion a year in lost revenue for the Government. But because it would boost the economy, I suspect it would actually improve the Government’s finances over a three- or four-year period.
But it's not going to happen...
I realise that a 4% cut in VAT is highly unlikely. And even if it did happen, I’m not suggesting that it would be a miracle cure that would solve all our problems.
But it would be worth doing. It would help.
Don't forget you can follow the 2013 Budget speech live here on lovemoney from 12.30pm GMT on Wednesday.